NvidiaOf (NASDAQ: NVDA ) The stock has gained more than 600 percent in the past two years. Much of this rally was driven by growth in the artificial intelligence (AI) market, which boosted sales of data center GPUs to process complex AI tasks.
Insatiable market demand for its data center chips is outstripping its available supply, and analysts expect Nvidia's revenue to grow at a compound annual growth rate (CAGR) of 45% from fiscal 2024 to fiscal 2027. (which will end in January 2027). They expect its earnings per share (EPS) to grow at a CAGR of 51%.
So even though Nvidia is already worth more than $3 trillion, it may still have plenty of room to maneuver. But before investors buy into this high-flying stock, they should pay attention to four red flags that could bring an unexpected end to its historic rally.
1. It has become an all-in play on AI chips.
In fiscal 2022 (which ends in January 2022), Nvidia generated 46% of its revenue from its gaming GPUs, 39% from its data center GPUs, and the rest from its professional concept, auto, and OEM chips. However, its product mix changed completely over the next two years as sales of its data center chips eclipsed its gaming chips.
In the first quarter of fiscal 2025, Nvidia derived 87% of its revenue from data center chips, 10% from gaming chips, and the remaining 3% from its other categories. It reported $22.6 billion in data center revenue in the same quarter, compared with roughly $27 billion in revenue in the same quarter. All of the financial year 2023. This amazing expansion transformed Nvidia from a more diversified GPU maker to an all-in player on AI chips.
That's fine if you believe Nvidia will continue to dominate the AI market as it expands. But if the AI market suddenly cools, Nvidia's chip shortages could lead to rapid supply. If its data center business takes off, it can't fall back on growth in its gaming segment and other smaller divisions to soften year-over-year comparisons.
2. It faces unexpected regulatory challenges.
Nvidia's heavy reliance on the AI market exposes it to a number of unexpected regulatory challenges. US regulators have repeatedly tightened their export restrictions on China's AI chip shipments, and that pressure could force Chinese chipmakers to accelerate development of their own AI chips.
Tighter regulations for generative AI technologies, which have already come into effect in Europe, could stifle the growth of a red-hot industry and curb companies' purchases of new AI chips. Complaints about rampant plagiarism and other ethical issues may also force AI companies to expand at a slower and more measured pace.
3. It faces obvious competitive threats.
According to JPR, Nvidia controls 88 percent of the discrete GPU market, but its biggest competitor AMD Introducing Inexpensive AI Accelerators AMD's MI300 Instinct GPUs already beat Nvidia's H100 GPUs — which cost nearly four times as much — in several industry benchmarks in terms of raw processing power and memory usage. Intel It also recently claimed that its new Gaudi 3 AI accelerator is faster and more powerful than Nvidia's H100 GPUs.
Super Microcomputer, which has grown rapidly over the past few years by developing dedicated AI servers powered by Nvidia's chips, is also developing new servers suitable for cheap AI accelerators from AMD and Intel. These cheaper servers could attract cost-conscious data center operators and chip away at Nvidia's market share.
Meanwhile, Nvidia's tight supply and high prices are driving away its top customers — including OpenAI, Microsoft, the alphabetGoogle of, and Amazon — to develop your own first-party AI accelerators. These chips won't threaten Nvidia's near-term growth, but they could slowly loosen its iron grip on the hyperscale data center market.
4. Its insiders are pure sellers.
Nvidia's stock isn't cheap at 49 times forward earnings and 26 times this year's sales. But if it has the potential to double or triple again in the near term, its valuations will appear reasonable and insiders should acquire more shares.
Yet over the past 12 months, Nvidia insiders sold more than 4 times as many shares as they bought. In the last three months, they sold 52 times more shares than they bought. These insider sales don't necessarily mean the stock is going down a cliff, but it's a worrisome trend that suggests its near-term upside is limited.
Is Nvidia stock still safe to buy?
I believe Nvidia is still worth buying, but investors shouldn't assume it's a great growth stock. Its transition from gaming company to AI was abrupt, and it may experience significant growing pains over the next few years. But assuming it overcomes all of these competitive, regulatory, and macro challenges, it should remain one of the easiest ways to capitalize on the secular expansion of the AI market.
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Suzanne Frey, an Alphabet executive, is a member of The Motley Fool's board of directors. John Mackey, former CEO of Whole Foods Market, is a member of the board of directors of The Motley Fool, an Amazon subsidiary. Leo Sun has positions in Amazon. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Amazon, Microsoft and Nvidia. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls on Intel, long January 2026 $395 calls on Microsoft, short August 2024 $35 calls on Intel, and short January 2026 $405 calls on Microsoft. The Motley Fool has a Disclosure Policy.
Nvidia Is a Top AI Stock, But Don't Ignore These 4 Red Flags Originally posted by The Motley Fool